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FM Final
FM Final
MEANING OF FINANCE :
Finance may be defined as the art and science of managing money. It includes financial service
and financial instruments. Finance also is referred as the provision of money at the time when it is
needed.
Finance function is the procurement of funds and their effective utilization in business concerns.
The concept of finance includes capital, funds, money, and amount. But each word is having
unique meaning. Studying and understanding the concept of finance become an important part
of the business concern.
FINANCIAL MANAGEMENT
DEFINITION OF BUSINESS FINANCE:
According to the Wheeler, “Business finance is that business activity which concerns
with the acquisition and conversation of capital funds in meeting financial needs
and overall objectives of a business enterprise”.
According to the Guthumann and Dougall, “Business finance can broadly be defined
as the activity concerned with planning, raising, controlling, administering of the
funds used in the business”.
In the words of Parhter and Wert, “Business finance deals primarily with raising,
administering and disbursing funds by privately owned business units operating
in nonfinancial fields of industry”.
Effective procurement and efficient use of finance lead to proper utilization of the
finance by the business concern. It is the essential part of the financial manager. Hence,
the financial manager must determine the basic objectives of the financial management.
Objectives of Financial Management may be broadly divided into two parts such as:
1. Profit maximization
2. Wealth maximization.
FINANCIAL MANAGEMENT
1. Profit maximization :
Main aim of any kind of economic activity is earning profit. A business concern is also
functioning mainly for the purpose of earning profit. Profit is the measuring techniques to
understand the business efficiency of the concern. Profit maximization is also the
traditional and narrow approach, which aims at, maximizes the profit of the concern.
2. Wealth maximization.
Wealth maximization is one of the modern approaches, which involves latest innovations
and improvements in the field of the business concern. The term wealth means
shareholder wealth or the wealth of the persons those who are involved in the business
concern.
Wealth maximization is also known as value maximization or net present worth
maximization. This objective is an universally accepted concept in the field of business.
FINANCIAL MANAGEMENT
FUNCTIONS OF FINANCE MANAGER :
Finance manager is one of the important role players in the field of finance function.
He must have entire knowledge in the area of accounting, finance, economics and
management. His position is highly critical and analytical to solve various problems
related
to finance. A person who deals finance related activities may be called finance manager.
Finance manager performs the following major functions:
3. Investment Decision
4. Cash Management
Financial Planning
Financial management helps to determine the financial requirement of the business
concern and leads to take financial planning of the concern. Financial planning is an
important part of the business concern, which helps to promotion of an enterprise.
Acquisition of Funds
Financial management involves the acquisition of required finance to the business
concern. Acquiring needed funds play a major part of the financial management, which
involve possible source of finance at minimum cost.
Financial Decision
Financial management helps to take sound financial decision in the business concern.
Financial decision will affect the entire business operation of the concern. Because there
is a direct relationship with various department functions such as marketing, production
personnel, etc.
Improve Profitability
Profitability of the concern purely depends on the effectiveness and proper utilization of
funds by the business concern. Financial management helps to improve the profitability
position of the concern with the help of strong financial control devices such as
budgetary control, ratio analysis and cost volume profit analysis.
Promoting Savings
Savings are possible only when the business concern earns higher profitability and
maximizing wealth. Effective financial management helps to promoting and mobilizing
individual and corporate savings.
ASSIGNMENT QUESTIONS
Simple Interest
Interest paid (earned) on only the original
amount, or principal, borrowed (lent).
•Compound Interest
Interest paid (earned) on any previous interest
earned, as well as on the principal borrowed
(lent).
Simple Interest Formula
Formula SI = P0(i)(n)
SI: Simple Interest
P0: Deposit today (t=0)
i: Interest Rate per Period
n: Number of Time Periods
Simple Interest Example
•SI = P0(i)(n) =
Rs.1,000(.07)(2) =
Rs.140
Simple Interest (FV)
FV = P0 + SI =
Rs.1,000 + Rs.140 = Rs.1,140
• Future Value is the value at some future time of a
present amount of money, or a series of payments,
evaluated at a given interest rate.
Simple Interest (PV)
20000
Future Value (INR)
10% Simple
15000 Interest
7% Compound
10000
Interest
5000 10% Compound
Interest
0
1st Year 10th 20th 30th
Year Year Year
Future Value
Single Deposit (Graphic)
0 1 2
7%
Rs.1,000
FV2
Future Value
Single Deposit (Formula)
FV1 = P0(1+i)1
FV2 = P0(1+i)2
0 1 2 3 4 5
10%
Rs.10,000
FV5
Story Problem Solution
= Rs.16,105.10
•Calculation based on Table I: FV5
= Rs.10,000 (FVIF10%, 5) =
Rs.10,000 (1.611) =
Rs.16,110 [Due to Rounding]
Present Value Single Deposit
(Graphic)
Rs.1,000
PV0 PV1
Present Value
Single Deposit (Formula)
0 1 2
7%
Rs.1,000
PV0
General Present Value Formula
etc.
General Present Value Formula:
PV0 = FVn / (1+i)n
or PV0 = FVn (PVIFi,n) -- See Table II
Valuation Using Table II
0 1 2 3 4 5
10%
Rs.10,000
PV0
Story Problem Solution
(Ordinary Annuity)
End of End of End of
Period 1 Period 2 Period 3
0 1 2 3
(Annuity Due)
Beginning of Beginning of Beginning of
Period 1 Period 2 Period 3
0 1 2 3
R R R
R = Periodic
Cash Flow
FVAn = R (FVIFAi%,n)
FVA3 = Rs.1,000
Period 6% (FVIFA
7% 7%,3)8%
1 = 1.000
Rs.1,000 1.000
(3.215) = 1.000
Rs.3,215
2 2.060 2.070 2.080
3 3.184 3.215 3.246
4 4.375 4.440 4.506
5 5.637 5.751 5.867
Overview View of an
Annuity Due -- FVAD
Cash flows occur at the beginning of the period
0 1 2 3 n-1 n
. . .
i%
R R R R R
Rs.1,145
Rs.1,225
FVAD3 = Rs.1,000(1.07)3 +
Rs.1,000(1.07)2 + Rs.1,000(1.07)1
Rs.3,440 =
= Rs.1,225 + Rs.1,145 + Rs.1,070
FVAD3
= Rs.3,440
Valuation Using Table III
FVADn = R (FVIFAi%,n)(1+i)
FVAD
Period
3 = Rs.1,000
6% (FVIFA
7% 7%,3)(1.07)
8%
1 = Rs.1,000
1.000 1.000(3.215)(1.07)
1.000 =
Rs.3,440
2 2.060 2.070 2.080
3 3.184 3.215 3.246
4 4.375 4.440 4.506
5 5.637 5.751 5.867
Overview of an
Ordinary Annuity -- PVA
Cash flows occur at the end of the period
0 1 2 n n+1
i% . . .
R R R
R = Periodic
Cash Flow
PVAn
PVAn = R/(1+i)1 + R/(1+i)2
+ ... + R/(1+i)n
Example of an
Ordinary Annuity -- PVA
Cash flows occur at the end of the period
0 1 2 3 4
7%
PVAn = R (PVIFAi%,n)
PVA3 = Rs.1,000
Period 6% (PVIFA
7% 7%,3)8%
1 = 0.943
Rs.1,000 0.935
(2.624) = 0.926
Rs.2,624
2 1.833 1.808 1.783
3 2.673 2.624 2.577
4 3.465 3.387 3.312
5 4.212 4.100 3.993
Overview of an
Annuity Due -- PVAD
Cash flows occur at the beginning of the period
0 1 2 n-1 n
i% . . .
R R R R
R: Periodic
PVADn Cash Flow
Rs.1,000.00 Rs.1,000
Rs.1,000
Rs. 934.58
Rs. 873.44
Rs.2,808.02 = PVADn
PVADn = R (PVIFAi%,n)(1+i)
PVAD
Period
3 = Rs.1,000
6% (PVIFA
7% 7%,3)(1.07)
8%
1 = Rs.1,000
0.943 0.935(2.624)(1.07)
0.926 =
Rs.2,808
2 1.833 1.808 1.783
3 2.673 2.624 2.577
4 3.465 3.387 3.312
5 4.212 4.100 3.993
Steps to Solve Time Value of
Money Problems
1. Read problem thoroughly
2. Create a time line
3. Put cash flows and arrows on time line
4. Determine if it is a PV or FV problem
5. Determine if solution involves a single CF, annuity
stream(s), or mixed flow
6. Solve the problem
7. Check with financial calculator (optional)
Mixed Flows Example
Julie Miller will receive the set of cash flows
below. What is the Present Value at a discount
rate of 10%.
0 1 2 3 4 5
10%
Rs.600 Rs.600 Rs.400
PV0 Rs.400 Rs.100
How to Solve?
1. Solve a “piece-at-a-time” by
discounting each piece back to t=0.
2. Solve a “group-at-a-time” by first
breaking problem into groups of annuity
streams and any single cash flow groups.
Then discount each group back to t=0.
“Piece-At-A-Time”
0 1 2 3 4 5
10%
Rs.600 Rs.600 Rs.400
Rs.545.45Rs.400 Rs.100
Rs.495.87
Rs.300.53
Rs.273.21
Rs. 62.09
Rs.1677.15 = PV0 of the Mixed Flow
“Group-At-A-Time” (#1)
0 1 2 3 4 5
10%
Rs.600 Rs.600 Rs.400
Rs.400 Rs.100
Rs.1,041.60
Rs. 573.57
Rs. 62.10
Rs.1,677.27 = PV0 of Mixed Flow [Using Tables]
0 1 2 3 4
General Formula:
FVn = PV0(1 + [i/m])mn
n: Number of Years m:
Compounding Periods per Year i: Annual
Interest Rate FVn,m: FV at the end of
Year n
PV0: PV of the Cash Flow today
Impact of Frequency
Julie Miller has Rs.1,000 to invest for 2 Years at an annual interest rate of
12%.
Annual FV2 = 1,000(1+ [.12/1])(1)(2) = 1,254.40
Semi FV2 = 1,000(1+ [.12/2])(2)(2) = 1,262.48
Impact of Frequency
Basket Wonders (BW) has a Rs.1,000 CD at the bank. The interest rate is
6% compounded quarterly for 1 year. What is the Effective Annual
Interest Rate (EAR)?
EAR = ( 1 + .06 / 4 )4 - 1 = 1.0614 - 1 =
.0614 or 6.14%!
Steps to Amortizing a Loan
1. Calculate the payment per period.
2. Determine the interest in Period t.
(Loan Balance at t-1) x (i% / m)
3. Compute principal payment in Period t.
(Payment - Interest from Step 2)
4. Determine ending balance in Period t.
(Balance - principal payment from Step 3)
5. Start again at Step 2 and repeat.
Amortizing a Loan Example
Julie Miller is borrowing Rs.10,000 at a compound
annual interest rate of 12%. Amortize the loan if
annual payments are made for 5 years.
Step 1: Payment
PV0 = R (PVIFA i%,n)
Rs.10,000 = R (PVIFA 12%,5)
Rs.10,000 = R (3.605)
R = Rs.10,000 / 3.605 = Rs.2,774
Amortizing a Loan Example
End of Payment Interest Principal Ending
Year Balance
0 --- --- --- $10,000
1 $2,774 $1,200 $1,574 8,426
2 2,774 1,011 1,763 6,663
3 2,774 800 1,974 4,689
4 2,774 563 2,211 2,478
5 2,775 297 2,478 0
$13,871 $3,871 $10,000
1. Jim makes a deposit of Rs.12,000 in a bank account. The deposit is to earn interest
annually at the rate of 9 percent for seven years.
a) How much will Jim have on deposit at the end of seven years?
b) Assuming the deposit earned a 9 percent rate of interest compounded
quarterly, how much would he have at the end of seven years?
c) In comparing parts (a) and (b), what are the respective effective annual yields?
Which alternative is better?
2. How many years will it take for Rs. 5000 invested today at 12% p.a. rate of interest
to grow to Rs. 160,000? Use rule of 72.
3. In how much period your Rs. 10,000 becomes Rs. 20,000 at 15% rate of interest,
using (a) Rule of 72, (b) Rule of 69.
FINANCIAL MANAGEMENT
ASSIGNMENT QUESTIONS
4. What is the present value of following cash flow stream at 10% p.a. rate of interest.
YEAR 0 1 2 3 4 5
5. Mr. X deposits Rs. 10,000 at the end of every year for 5 years in his savings
account paying 5% p.a. interest. How much money he will get at the end of 5
years?
6. Mr. X is planning to buy a car after 5 years when it is expected to cost Rs. 5 Lakh.
How much he should save annually to reach his target if his savings earn a
compound annual interest rate of 12%?
7. A travel operator announces that it can take anybody on a world tour at a price of
Rs. 2,00,000. I wish to avail this offer. I can save Rs. 25,000 annually and my
savings earn 10% p.a. compound interest. How long I will have to wall?
8. You invest Rs. 3000 a year for 3 years and Rs. 5000 a year for 7 years thereafter at
interest rate of 12% p.a. What will be the maturity value at the end of 10 years?
FINANCIAL MANAGEMENT
ASSIGNMENT QUESTIONS
8. You invest Rs. 3000 a year for 3 years and Rs. 5000 a year for 7 years thereafter at
interest rate of 12% p.a. What will be the maturity value at the end of 10 years?
8. Sunil is due to retire 20 years from now. He wants to invest a lump sum now so as
to be able to withdraw Rs. 10,000 every year, beginning from the end of the 20th
year. How much he should invest now if r = 12%?
9. “Individuals have a time preference for money”. Give reasons for such a preference
and explain the relation between time preference rate and required rate of return.
10. What is the relevance of “Time value of Money in financial decision making”.
11. Write Short notes on.
a. Annuity.
b. Sinking fund
c. Effective rate of return.
FINANCIAL MANAGEMENT
SOURCES OF FINANCE
INTRODUCTION
Arrangement of the required finance to each department of business concern is highly
a complex one and it needs careful decision. Quantum of finance may be depending
upon the nature and situation of the business concern. But, the requirement of the
finance may be broadly classified into two parts:
2. Based on Ownership
● Equity Shares
● Preference Shares
● Debenture
● Long-term Loans
● Fixed Deposits
FINANCIAL MANAGEMENT
SOURCES OF FINANCE
Short-term sources: Apart from the long-term source of finance, firms can
generate finance with the help of short-term sources like loans and advances from
commercial banks, moneylenders, etc. Short-term source of finance needs to meet
the operational expenditure of the business concern.
1. Less cost of capital: Cost of capital is the major factor, which affects the value
of the company. If the company wants to increase the value of the company, they have
to use more share capital because, it consists of less cost of capital (Ke) while
compared to other sources of finance.
5. Retained earnings: When the company have more share capital, it will be
suitable for retained earnings which is the less cost sources of finance while compared
to other sources of finance.